Gordon Brown Sold Britain’s Gold at Artificially Low Prices to Bail Out a Large American Bank

One decision stands out as downright bizarre, however: the sale of the majority of Britain’s gold reserves for prices between $256 and $296 an ounce ….

When Brown decided to dispose of almost 400 tonnes of gold between 1999 and 2002, he did two distinctly odd things.

First, he broke with convention and announced the sale well in advance, giving the market notice that it was shortly to be flooded and forcing down the spot price. This was apparently done in the interests of “open government”, but had the effect of sending the spot price of gold to a 20-year low, as implied by basic supply and demand theory.

Second, the Treasury elected to sell its gold via auction. Again, this broke with the standard model. The price of gold was usually determined at a morning and afternoon “fix” between representatives of big banks whose network of smaller bank clients and private orders allowed them to determine the exact price at which demand met with supply.

The auction system again frequently achieved a lower price than the equivalent fix price. The first auction saw an auction price of $10c less per ounce than was achieved at the morning fix. It also acted to depress the price of the afternoon fix which fell by nearly $4.

It seemed almost as if the Treasury was trying to achieve the lowest price possible for the public’s gold. It was.

One of the most popular trading plays of the late 1990s was the carry trade, particularly the gold carry trade.

In this a bank would borrow gold from another financial institution for a set period, and pay a token sum relative to the overall value of that gold for the privilege.

Once control of the gold had been passed over, the bank would then immediately sell it for its full market value. The proceeds would be invested in an alternative product which was predicted to generate a better return over the period than gold which was enduring a spell of relative price stability, even decline.

At the end of the allotted period, the bank would sell its investment and use the proceeds to buy back the amount of gold it had originally borrowed. This gold would be returned to the lender. The borrowing bank would trouser the difference between the two prices.

This plan worked brilliantly when gold fell and the other asset – for the bank at the heart of this case, yen-backed securities – rose. When the prices moved the other way, the banks were in trouble.

This is what had happened on an enormous scale by early 1999. One globally significant US bank in particular is understood to have been heavily short on two tonnes of gold, enough to call into question its solvency if redemption occurred at the prevailing price.

Goldman Sachs, which is not understood to have been significantly short on gold itself, is rumoured to have approached the Treasury to explain the situation through its then head of commodities Gavyn Davies, later chairman of the BBC and married to Sue Nye who ran Brown’s private office.

Faced with the prospect of a global collapse in the banking system, the Chancellor took the decision to bail out the banks by dumping Britain’s gold, forcing the price down and allowing the banks to buy back gold at a profit, thus meeting their borrowing obligations.

I spoke with Peter Hambro, chairman of Petroplavosk and a leading figure in the London gold market, late last year and asked him about the rumours above.

“I think that Mr Brown found himself in a terrible position,” he said.

“He was facing a problem that was a world scale problem where a number of financial institutions had become voluntarily short of gold to the extent that it was threatening the stability of the financial system and it was obvious that something had to be done.”

***

Responsibility is evaded by all bar those on whose shoulders it ought to rest. The gold panic of 1999 was expensively paid for by the British public.

JP Morgan was wildly short gold in 1999. See this and this. As Reginald Howe has noted:

Prior to 1999, [JP] Morgan had never held more than about $20 billion in total gold derivatives, nor more than 28% of the total outstanding for all banks. But beginning in the second quarter of 1999 [before Brown announced the British gold sales], Morgan took on a much larger role in the under-one-year maturities, possibly presaging the the British gold sales. Then, during the last half of 1999, Morgan more than doubled its total gold derivatives, taking them from $18.4 billion to $38.1 billion, which amounted to 43% of the total for all U.S. banks reporting to the Comptroller of the Currency. What is more, Morgan’s over 40% dominance stretched across all maturities. In the fourth quarter alone, it increased its gold derivatives with maturities over one year by more than 80% to $17.1 billion from $9.4 billion.

(Citi was the third American bank with a huge short gold position in 1999, trailing JP Morgan with the biggest position and Goldman with the second largest.)

Private counterparties in oil contracts have virtually no ability to restrict the worldwide supply of this commodity. (Even OPEC has been less than successful over the years.) Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.

Gold may have been manipulated like the London interbank rate or Libor over a long time frame, Ned Naylor-Leyland, investment director at Cheviot [with around $300 million under management], told CNBC.

The scandal surrounding the fixing of the Libor has opened markets up to “more scrutiny and more investigation,” Naylor-Leyland said.

He expects to see revelations over the next few months that the price of gold was also manipulated because “gold and silver reflect the true value of money the same way interest rates do.”

“It is effectively an intervention in two ways; one would be the fact that for central banks, gold and silver going up doesn’t make their currency look any good, and secondly a number of the big commercial banks have very large short positions which they like to manage and make easy money from,” he said.

***

Chris Powell, Secretary and Treasurer of the Gold Anti-Trust Action Committee told CNBC in June that “as central banks are interested in supporting government bonds and the dollar and keeping interest rates low, they continue to manipulate the gold market”.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

4 Responses to “Governments Don’t Manipulate the Price of Gold … Do They?”

“One globally significant US bank in particular is understood to have been heavily short on two tonnes of gold, enough to call into question its solvency if redemption occurred at the prevailing price.”

If the price of gold was around $300 an ounce, then two metric tons would be worth about $20 million. What “globally significant” bank would be driven under by that? How bad of a bet would you have had to make?

“If the price of gold was around $300 an ounce, then two metric tons would be worth about $20 million. What “globally significant” bank would be driven under by that? How bad of a bet would you have had to make?”
…

That would be the value at the current price. The implication is that a large move against the institution could add up to a much larger loss. Liquidation of a position in such circumstances is not easy for a large institution. Even making the decision to liquidate could take a long period of time especially when the reason for the trade was based on price stability.

Again I say, how much larger? I mean when Citibank got bailed out for its loans to Mexico, the deal was around $20 Billion, not million. A bad bet on gold seems trivial in comparison. Show me the math, or I’m just not buying it.

Central banks buy and sell gold to put money into and take money out of the system, respectively. Now a days, they don’t even have to do it physically, just notionally because the paper market is a lot more liquid. Until a real physical divergence is revealed, no one’s going to call them on it.

Don’t make up any more skullduggery than there is. I tire of those who smell palace intrigue at every whiff of flatulence.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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